Profit Margin vs. Markup: An Overview
Profit margin and markup are separate accounting terms that use the same inputs and analyze the same transaction, yet they show different information. Both profit margin and markup use revenue and costs as part of their calculations. The main difference between the two is that profit margin refers to sales minus the cost of goods sold while markup to the amount by which the cost of a good is increased in order to get to the final selling price.
An appropriate understanding of these two terms can help ensure that price setting is done appropriately. If price setting is too low or too high, it can result in lost sales or lost profits. Over time, a company's price setting can also have an inadvertent impact on market share, since the price may fall far outside of the prices charged by competitors.
- Profit margin and markup are separate accounting terms that use the same inputs and analyze the same transaction, yet they show different information.
- Profit margin refers to the revenue a company makes after paying the cost of goods sold (COGS).
- Markup is the retail price for a product minus its cost.
An understanding of the terms revenue, cost of goods sold (COGS), and gross profit are important. In short, revenue refers to the income earned by a company for selling its goods and services. COGS refers to the expenses incurred by manufacturing or providing goods and services. Finally, gross profit refers to any revenue left over after covering the expenses of providing a good or service.
Profit margin refers to the revenue a company makes after paying COGS. The profit margin is calculated by taking revenue minus the cost of goods sold. However, the difference is shown as a percentage of revenue. The percentage of revenue that is gross profit is found by dividing the gross profit by revenue. For example, if a company sells a product for $100 and it costs $70 to manufacture the product, its margin is $30. The profit margin, stated as a percentage, is 30% (calculated as the margin divided by sales).
Profit margin is sales minus the cost of goods sold. Markup is the percentage amount by which the cost of a product is increased to arrive at the selling price.
Markup shows how much more a company's selling price is than the amount the item costs the company. In general, the higher the markup, the more revenue a company makes. Markup is the retail price for a product minus its cost, but the margin percentage is calculated differently. In our earlier example, the markup is the same as gross profit (or $30), because the revenue was $100 and costs were $70. However, markup percentage is shown as a percentage of costs, as opposed to a percentage of revenue.
Using the same numbers as above, the markup percentage would be 42.9%, or ($100 in revenue – $70 in costs) / $70 costs.
Profit margin and markup show two aspects of the same transaction. Profit margin shows profit as it relates to a product's sales price or revenue generated. Markup shows profit as it relates to costs.
Markup usually determines how much money is being made on a specific item relative to its direct cost, whereas profit margin considers total revenue and total costs from various sources and various products.